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Manufacturing Capacity Is Leaving China. But Where's It Going?

We've heard it before: manufacturing is leaving China and coming back to the West. But the reality isn't that simple.

Manufacturing Capacity Is Leaving China. But Where's It Going?

A new study from the University of Tennessee on outsourcing and global supply chains finds that manufacturing capacity is indeed shifting away from China and other parts of Asia. The rush to those countries was motivated by a desire to slash production costs through the use of cheap labor.

Original equipment manufacturers, however, soon found out that China wasn’t the panacea that they had expected. They hadn’t taken into account costs associated with the extra distance, and the difficulty of sustaining the flow of product to markets in the West. In many cases, they were forced to keep expensive safety stock on hand, as protection against inevitable disruptions in their lengthy supply chains.

What they’re doing now, however, is anything but a return to the habits of the past. According to the UT study, companies are adopting a regional model of manufacturing worldwide, not just in the U.S.

The study is of admittedly small scale. It looked at just 10 companies, selecting those that were the most advanced in their global networks and supply-chain design strategies, says co-author Ted Stank, who holds the Bruce Chair of Excellence at UT. (Other authors of the study, carried out under the auspices of UT’s Global Supply Chain Institute, were Mike Burnette and Paul Dittmann.)

The initiative actually has its roots in a book by Stank and three co-authors that was published last year, Global Supply Chains: Evaluating Regions on an EPIC Framework. “EPIC” is an acronym for economics, politics, infrastructure and competencies (which include management talent and labor). The culmination of three years of work, the book offered a means of measuring the supply-chain potential of various regions of the world.

Stank says it arose out of a sense that companies were on the verge of shifting to a regional focus for manufacturing and distribution. No more of that one-size-fits-all approach, predicated entirely on the cost of factory labor.

The effort was by no means America-centric. Among the co-authors was Philippe-Pierre Dornier, professor of operations management at ESSEC Business School in Paris. On the contrary, it divides the world into 10 distinct regions, assessing 55 countries according to the four elements that make up the EPIC framework. In the process, it scores each location according to its attractiveness as a site for manufacturing in support of local markets.

The new study builds on the conclusions of the earlier book by interviewing those 10 real-world companies about their own global strategies. The idea, says Stank, was to come up with a number of best practices by leading businesses in the development of supply-chain networks.

The results validate the authors’ contention that regionalization is on the rise, driven in part by the rising cost of manufacturing offshore. In China alone, the price of labor has experienced double-digit increases over the past 10 years.

“I can firmly say that after four years, the general trend is toward regional operations, at least for part of a bill of materials,” Stank says. Certain products or commodities will continue to be sourced centrally in areas of lowest-cost labor, he adds, but the making of higher-valued goods will be distributed widely, in line with targeted areas of demand.

Why the move now? Stank says companies are becoming more sophisticated in their approach to network design. They’re adopting better cost models that refute “knee-jerk decisions over 20 years of experience.” They’re discovering the major areas of expense that they missed the first time around: transportation, regulatory compliance, currency exchange and general supply-chain risk.

Businesses have been hit hard in recent years by a string of natural disasters and political upheavals. At the same time, the price of fuel has seesawed, forcing a periodic recalculation of key supply-chain costs. Such events have made the need for good risk management “much higher in our consciousness than 20 years ago,” Stank says.

Which companies will benefit from regionalization depends on a few key characteristics of their products and supply networks. If the cost of goods sold is relatively low compared with logistics cost, then it might be time to rethink offshoring strategies. Also a factor is the degree to which sales volumes are distributed around the world.

The study did find some relocation of manufacturing back to the U.S. Despite high labor costs and a crumbling infrastructure, “when you compare it to many areas of the world, there is a heck of a lot to be said for the overall EPIC system that we have in the U.S. in certain industries,” says Stank.

Mexico and Latin America, though, probably stand to gain more from the shift than the U.S. They offer a combination of lower labor costs and proximity to major consumer markets. Panama, in particular, stands to benefit from the assembly of subcomponents made in Asia, if it can realize certain improvements in its own infrastructure.

Taking a global view, the study draws on the concept of the regional pod, a term popularized by economist and New York University Professor Pankaj Ghemawat. It refers to areas that are relatively unique from a geographic standpoint, and which generate high levels of demand that can be supported through local supply-chain infrastructure. The 10 areas identified in the UT study are East Asia, South Asia, Southeast Asia, Australia and New Zealand, Middle East and North Africa, sub-Saharan Africa, Eastern and Central Europe, Western Europe, North and Central America, and South America.

Those regions vary, of course, in their quality of manufacturing and distribution infrastructure. Eastern Europe, for example, is among those showing the biggest growth in recent years, while Western Europe continues to suffer from high production costs and economic fragmentation.

Whether or not companies choose the path of regionalization, global supply chains are growing ever more complex. “A basic premise of the book and the study is that managers need to get more informed and sophisticated about issues that were black-boxed before,” says Stank.

Corporate review cycles need to be shorter as well. “At one point, a company might have looked at its overall logistics network every five years,” says Stank. “Now we’re seeing the best companies bringing capabilities in-house to do almost dynamic analyses at the network-design level.” The picture never stops changing.

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A new study from the University of Tennessee on outsourcing and global supply chains finds that manufacturing capacity is indeed shifting away from China and other parts of Asia. The rush to those countries was motivated by a desire to slash production costs through the use of cheap labor.

Original equipment manufacturers, however, soon found out that China wasn’t the panacea that they had expected. They hadn’t taken into account costs associated with the extra distance, and the difficulty of sustaining the flow of product to markets in the West. In many cases, they were forced to keep expensive safety stock on hand, as protection against inevitable disruptions in their lengthy supply chains.

What they’re doing now, however, is anything but a return to the habits of the past. According to the UT study, companies are adopting a regional model of manufacturing worldwide, not just in the U.S.

The study is of admittedly small scale. It looked at just 10 companies, selecting those that were the most advanced in their global networks and supply-chain design strategies, says co-author Ted Stank, who holds the Bruce Chair of Excellence at UT. (Other authors of the study, carried out under the auspices of UT’s Global Supply Chain Institute, were Mike Burnette and Paul Dittmann.)

The initiative actually has its roots in a book by Stank and three co-authors that was published last year, Global Supply Chains: Evaluating Regions on an EPIC Framework. “EPIC” is an acronym for economics, politics, infrastructure and competencies (which include management talent and labor). The culmination of three years of work, the book offered a means of measuring the supply-chain potential of various regions of the world.

Stank says it arose out of a sense that companies were on the verge of shifting to a regional focus for manufacturing and distribution. No more of that one-size-fits-all approach, predicated entirely on the cost of factory labor.

The effort was by no means America-centric. Among the co-authors was Philippe-Pierre Dornier, professor of operations management at ESSEC Business School in Paris. On the contrary, it divides the world into 10 distinct regions, assessing 55 countries according to the four elements that make up the EPIC framework. In the process, it scores each location according to its attractiveness as a site for manufacturing in support of local markets.

The new study builds on the conclusions of the earlier book by interviewing those 10 real-world companies about their own global strategies. The idea, says Stank, was to come up with a number of best practices by leading businesses in the development of supply-chain networks.

The results validate the authors’ contention that regionalization is on the rise, driven in part by the rising cost of manufacturing offshore. In China alone, the price of labor has experienced double-digit increases over the past 10 years.

“I can firmly say that after four years, the general trend is toward regional operations, at least for part of a bill of materials,” Stank says. Certain products or commodities will continue to be sourced centrally in areas of lowest-cost labor, he adds, but the making of higher-valued goods will be distributed widely, in line with targeted areas of demand.

Why the move now? Stank says companies are becoming more sophisticated in their approach to network design. They’re adopting better cost models that refute “knee-jerk decisions over 20 years of experience.” They’re discovering the major areas of expense that they missed the first time around: transportation, regulatory compliance, currency exchange and general supply-chain risk.

Businesses have been hit hard in recent years by a string of natural disasters and political upheavals. At the same time, the price of fuel has seesawed, forcing a periodic recalculation of key supply-chain costs. Such events have made the need for good risk management “much higher in our consciousness than 20 years ago,” Stank says.

Which companies will benefit from regionalization depends on a few key characteristics of their products and supply networks. If the cost of goods sold is relatively low compared with logistics cost, then it might be time to rethink offshoring strategies. Also a factor is the degree to which sales volumes are distributed around the world.

The study did find some relocation of manufacturing back to the U.S. Despite high labor costs and a crumbling infrastructure, “when you compare it to many areas of the world, there is a heck of a lot to be said for the overall EPIC system that we have in the U.S. in certain industries,” says Stank.

Mexico and Latin America, though, probably stand to gain more from the shift than the U.S. They offer a combination of lower labor costs and proximity to major consumer markets. Panama, in particular, stands to benefit from the assembly of subcomponents made in Asia, if it can realize certain improvements in its own infrastructure.

Taking a global view, the study draws on the concept of the regional pod, a term popularized by economist and New York University Professor Pankaj Ghemawat. It refers to areas that are relatively unique from a geographic standpoint, and which generate high levels of demand that can be supported through local supply-chain infrastructure. The 10 areas identified in the UT study are East Asia, South Asia, Southeast Asia, Australia and New Zealand, Middle East and North Africa, sub-Saharan Africa, Eastern and Central Europe, Western Europe, North and Central America, and South America.

Those regions vary, of course, in their quality of manufacturing and distribution infrastructure. Eastern Europe, for example, is among those showing the biggest growth in recent years, while Western Europe continues to suffer from high production costs and economic fragmentation.

Whether or not companies choose the path of regionalization, global supply chains are growing ever more complex. “A basic premise of the book and the study is that managers need to get more informed and sophisticated about issues that were black-boxed before,” says Stank.

Corporate review cycles need to be shorter as well. “At one point, a company might have looked at its overall logistics network every five years,” says Stank. “Now we’re seeing the best companies bringing capabilities in-house to do almost dynamic analyses at the network-design level.” The picture never stops changing.

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Manufacturing Capacity Is Leaving China. But Where's It Going?